Ray Dalio is the founder of Bridgewater, arguably the world’s most successful hedge fund.
He’s just put out an interesting piece on “paradigm shifts” in markets.
To cut a long story short, markets go through long periods of behaving in a certain way. Once this behaviour becomes unsustainable (because people get used to it and start taking it for granted), market behaviour often flips.
In other words, you get a paradigm shift.
Why does this matter? Because Dalio reckons we must be getting pretty close to such a shift now.
Preparing for a paradigm shift
Dalio points out that each decade since the 1920s (at least) has had a different investment “paradigm”, which often creates the conditions that give rise to the big shifts. To be clear, this is based on the US experience, which is not universal by any means.
So the boom days of the roaring ‘20s, gave way to the depressionary era of the 1930s. And the boom of the ‘60s, gave way to the stagflation of the ‘70s, which created the conditions for the long, secular decline in inflation and interest rates that began in the ‘80s.
Since the post-2008 era, we’ve been in a “reflationary” paradigm (at least when it comes to asset prices). But Dalio is concerned that this has taken us to a point where central bank policy is running out of steam.
By driving down interest rates and boosting asset prices, central banks have effectively pulled forward returns from the future. As we all know, one of the biggest influences on future returns (after costs) is valuation. If you buy stuff when it’s expensive, your long-term returns will be lower than if you buy stuff when it’s cheap.
Dalio’s point is that eventually central banks will push asset prices up to the point where future expected returns are no better than those on cash. The closer you get to that point, the less inclined investors will be to buy those assets because the expected returns simply won’t be appealing enough, regardless of how low rates are.
In turn, if you can’t convince investors to continue buying things like government debt with negative yields, then you have two choices. You either allow interest rates to rise (which would be painful for an awful lot of people and countries), or you hold interest rates down and print money to pay off the debt, weakening your currency in the process.
Either way, bondholders get stiffed.
So what can you own at a time when trust in paper assets and the like is falling? (And this is before we get on to the more general lack of trust in society, between the wealthy and the less-well-off).
Well, Dalio reckons that it all means that the assets that will “most likely do best will be those that do well when the value of money is being depreciated and domestic and international conflicts are significant… I believe it would be both risk-reducing and return-enhancing to consider adding gold to one’s portfolio.”